Don’t fear the yield curve

There are always a lot of things to worry about in our economy. The yield curve isn’t one of them.

What is it about us humans that attracts us to negative news and, especially, negative forecasts? It might be worries about our fragile existence, but whether it is this or some less cosmic cause we do love our doomsayers.

It isn’t a product of our times. In literature, for example, we have Shakespeare, who understood human nature as well as anyone, having Julius Caesar warned by a soothsayer to “beware the ides of March.” Earlier, of course, the Greeks had their Oracle at Delphi, where Pythia foretold the future. Delphic forecasts tended to be worded such that they would come true no matter what occurred — a tendency memorialized in our language as “oracular.”

While there are some similarities, oracular is too harsh a term for the “inverted yield curve” as an economic indicator. Rightly or wrongly, it did furnish the basis for the recent flurry of doomsaying and investor worries about a recession. But as a predictor, it is less than perfect.

A yield curve is a line graph that shows and compares market interest rates for short-term and long-term debt securities having the same credit risk but different maturities. While there are as many yield curves as there are debt securities, the yield curve most commonly referred to is for U.S. Treasury bonds.

A normal yield curve slopes upward; that is, the interest rate goes up as the maturity date gets farther and farther away from the present and the perceived risk rises. It’s called a yield curve because the interest rate shown on it is the effective interest rate, which takes into account the current market price paid for the bond — which may in fact be higher or lower than the original par value.

It’s called a curve because economists call almost all line graphs curves, even those that resemble or are straight lines. Real yield curves typically are curved, but occasionally are nearly straight. The theoretical, “normal” yield curve is straight and rises as the time to maturity increases.

Inverted yield curves slope downward and have preceded a lot of recessions but if it were a dependable indicator we would have shut down our economic research and forecasting efforts a long time ago. To start with, the negative yield curve as an indicator leaves out a couple of key pieces of information: time and intensity.

Throughout American history our economy has never been in equilibrium. It was and is always expanding or contracting. If the economy is expanding, then, it doesn’t take a genius or a fortune teller to say that a recession is coming. You will probably be right…eventually. And that is equally true if the economy is in recession and you predict that a recovery is coming. Right again, eventually.

An economy predictor that leaves out the “when” entirely or provides a wide block of time is of limited value, similar to predictions of the “big one” hitting California maybe tomorrow or maybe in 10,000 years.

The second thing left out is a measure of intensity. Just how negative is the yield curve? It would make sense that a steeply sloped negative yield curve would be a stronger indicator than one that was barely negative. But all negative yield curves are lumped together, usually, and many investment analysts reach for the alarm bell whenever the yield curve starts to flatten out.

The yield curve is all about investor expectations — for the economy and, more particularly, for the Fed’s monetary policy position. If investors believe that the Fed is going to raise interest rates to cool down the inflationary forces in the economy they will respond by shifting demand, which tends to flatten out the yield curve.

The yield curve itself does not present a threat to the U.S. economy, but it does reflect a change in bond investor expectations about Federal Reserve actions and about the durability of our current economic expansion, now just 12 months away from being the longest in history.

Much of our economy relies on debt, and the so-called “entitlement” sector of government spending is dependent on investors parting with cash to purchase trillions of dollars of the federal government’s debt. That means that the investor expectations reflected in the yield curve have some weight. However, it is good to remember that the negative yield curve may simply be the result of a delayed reaction of long-term interest rates to the economy’s expansion. If long-term rates were to rise, the inversion of the yield curve would disappear.

There are always a lot of things to worry about in our economy — short range and long range. The yield curve, however. isn’t one of them. It just shows that some other people are worried, too. It doesn’t mean that they are right.

James McCusker is a Bothell economist, educator and consultant.

Talk to us

More in Herald Business Journal

The 214-foot tall cranes work to unload their first cargo shipments at South Terminal at the Port of Everett on Thursday, April 8, 2021 in Everett, Wa. (Olivia Vanni / The Herald)
Renovated Port of Everett terminal gets first cargo customer

The 655-foot Westwood Columbia is the first ship to call at the newly upgraded South Terminal dock.

Project Roxy is a proposed 2.8 million square foot distribution center that would be built on a 75-acre parcel at the Cascade Industrial Center. The rendering depicts the proposed project at 4620 172nd Street in Arlington from a northwest perspective.
1,000 jobs: Amazon to open distribution center in Arlington

The company is the tenant behind Project Roxy, a $355 million building at the Cascade Industrial Center.

Garry Clark, the new CEO of Economic Alliance Snohomish County (Kevin Clark / The Herald)
At a tough time, a new CEO leads local economic development

Garry Clark has taken the helm at Economic Alliance Snohomish County, where job one is pandemic recovery.

Kathy Coffey (left) and Courtney Wooten
Leadership Snohomish County offers racial equity conference

The fifth annual day-long Step Up: Moving Racial Equity Forward will be held online on April 30.

Signs from the Department of Ecology warning about contamination in the creek that runs through Powder Mill Gulch on Wednesday, March 31, 2021 in Everett, Wa. (Olivia Vanni / The Herald)
State order targets Boeing Everett plant’s polluted history

Records show a dispute over cleanup requirements for chemically tainted water. The company denies there’s a disagreement.

FILE- In this Sept. 30, 2020, file photo, a Boeing 737 Max jet, piloted by Federal Aviation Administration (FAA) chief Steve Dickson, prepares to land at Boeing Field following a test flight in Seattle. Boeing says it has informed 16 of its customers that they should address a possible electrical issue in certain 737 Max aircraft before using them further. Boeing said Friday, April 9, 2021, that the recommendation was made “to allow for verification that a sufficient ground path exists for a component of the electrical power system.” (AP Photo/Elaine Thompson, File)
Boeing: possible electrical issue in some 737 Max aircraft

The company said that the new problem was unrelated to the flight-control system.

Aerospace supplier with Everett site files for bankruptcy

Wichita-based TECT Aerospace filed for Chapter 11 and plans to sell an Everett manufacturing facility.

Edmonds grocery store workers may soon earn hazard pay

Some employers are required to increase wages by $4 an hour, the city council voted Tuesday.

What local firms are doing to promote diversity and equity

Here’s how some of Snohomish County’s biggest companies and organizations say they are making a difference.

Washington's Lottery ticket display. (Andrea Brown / The Herald)
Want to get lucky? Washington’s Lottery lists Top 10 stores

One of the luckiest retailers in the state was a Safeway in Everett, as measured by $1,000-plus winners.

Boeing President Ron Woodard, fifth from left, breaks ground with Boeing officials to make way for the Boeing Commercial Airplane Group Headquarters Office Building at the Longacres Park site in Renton Wash. Wednesday, May 14, 1997. (AP Photo/Loren Callahan)
For sale: Boeing’s Commercial Airplanes headquarters in Renton

A large warehouse on the Bomarc property in Everett also is for sale.

Snehal Patel, Global Head of Cell Therapy Manufacturing at Bristol Myers Squibb, stand outside the facility on Monday, March 29, 2021 in Bothell, Washington. A Bristol Myers Squibb facility in Bothell is one of four facilities in the United States where the company supercharges a person's T-cells to better fight blood cancers. The facility uses a virus  -- a viral delivery system -- to add punch to an individual's T-cells. The T-cells are then returned to the person better-equipped to destroy cancer cells.  (Andy Bronson / The Herald)
Cancer patients nationwide send their blood cells to Bothell

At a Bristol Myers Squibb lab, the cells are altered and returned to patients fighting non-Hodgkin’s lymphoma.